Glossary_Term: Lenders look at your existing debt payments plus the projected payment for the new loan, and then calculate what percentage that represents of your total pre-tax income. This percentage is your debt-to-income ratio, which is one of the factors lenders use to decide whether or not to extend you a loan or line of credit. Generally, the lower your debt-to-income ratio is, the more likely you are to qualify.

How to calculate it

Lenders calculate your debt-to-income ratio by using these steps:

Add up the amount you pay each month for debt and recurring financial obligations (such as credit cards, car loans and leases, or student loans). Don’t include your current mortgage or rental payment or other monthly expenses that aren’t debts (such as phone or electric bills) in this number.

Add your projected future mortgage, home equity loan or line of credit payment to your debt total from step 1.

Divide that total number by your monthly pre-tax income. The resulting percentage is your debt-to-income ratio.

For example, if your monthly income is $5,000 and your monthly debts plus your monthly projected mortgage, home equity loan or line of credit payments are $1,000, your debt-to-income ratio would be 20%.

Lowering your debt-to-income ratio

Most lenders will want your debt–to-income ratio to be no more than 36%, but some lenders or loan products may require a lower percentage in order to qualify.

If your DTI ratio is too high, consider how you can lower it. You might be able to pay down your credit cards or reduce other monthly debts. If the proceeds from your current home’s sale plus your savings allow it, you may also want to increase the amount of your down payment, in order to lower the projected Glossary_Term: monthly mortgage payment. Or you may want to consider a less expensive home.

Also keep in mind that there are alternative sources of income. Some lenders may consider other non-traditional sources of income (for example, trust income or housing allowance) in addition to your traditional income. Be sure to ask your lender about the availability of mortgage products and programs that allow the use of non-traditional sources of income.

By understanding what your debt picture looks like, you can develop a plan to tackle it.

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Lender

Debt

An amount of money owed by one person, company, organization, or other entity to another.

Monthly payment

The amount paid each month toward the principal and interest amount of a loan. The monthly payment may or may not include taxes and insurance.

Refinancing

Paying off one loan with the proceeds from another loan, generally using the same property as collateral.

Line of credit

An agreement by a lender to extend credit up to a maximum amount for a specified time. In a home equity line of credit, the line of credit is secured by the borrower’s home.

Mortgage

A legal document giving a lender a lien on real estate to secure repayment of a loan. Mortgage loans generally run from 10 to 30 years, after which the loan is required to be paid off. Also called deed of trust and/or security deed.

Home equity loan

An installment loan (a loan which is repaid in equal amounts over a period of time) secured by the equity in a borrower's residence. It can be used for home improvements, debt consolidation and other major purchases or expenses. Interest on these loans may be tax deductible. (Consult a tax advisor and IRS Publication 936, Mortgage Interest Deduction, regarding deductibility of interest.) On the funding date (after the applicable rescission period), all of the principal is advanced for the benefit of the borrower(s).

Debt-to-income ratio

Debt-to-income ratio is the percentage of your gross monthly income (before taxes are taken out) that you pay toward debt (loans, credit cards, court-ordered payments), as well as your projected total monthly home payment. It also will include HOA dues and private mortgage insurance, if applicable.

What you Owe vs. What You Make from Bank of AmericaYour debt-to-income ratio (or DTI) will play an important part in mortgages, refinancing and lines of credit.What is debt-to-income ratio?Bank of AmericaYour debt-to-income ratio (or DTI) will play an important part in mortgages layer, refinancing and home equity loans or lines of credit layer. But what is it exactly? Simply put, it is the percentage of your monthly income that is taken up by your monthly debt payments.
Lenders look at your existing debt payments plus the projected payment for the new loan, and then calculate what percentage that represents of your total pre-tax income. This percentage is your debt-to-income ratio, which is one of the factors lenders use to decide whether or not to extend you a loan or line of credit. Generally, the lower your debt-to-income ratio is, the more likely you are to qualify.what you owe vs. what you make